Rethinking the Rogoff-Reinhart thesis: this time, things may not be different ... from the 1930s.

• Author: Connolly, Bernard
• Position: This Time Is Different: Eight Centuries of Financial Folly - Book review

Economic historian Niall Ferguson has written of This Time Is Different: Eight Centuries of Financial Folly, by Carmen Reinhart and Ken Rogoff, that "lifts single marvelous volume is worth a thousand mathematical models." That might be considered an instance of damning with praise, but it was certainly not intended--nor should it have been, for the book is indeed marvelous. But while the book itself is extremely valuable, what have become known as the Reinhart-Rogoff theses popularly derived from it are a decidedly mixed blessing.

Popular (and policymaker) discussion of the book has erected two propositions. First, that since the Reinhart-Rogoff research shows that output and employment have always had a hard time recovering after a banking crisis, the slowness (or absence) of recovery in many countries now is a function of the state of the banking system and that regulatory or organizational reform of that system is necessary for stronger recovery to be possible. Second, because it seems that growth may have been adversely affected in countries where the public debt ratio exceeds 90 percent, "austerity" aimed at ensuring ratios below that level is a necessary and sufficient condition for faster growth.

Now it is undoubtedly true that the world would be in better shape if its banking system were healthier. And it is equally true that high public debt ratios are indicative of something that has gone badly wrong. The problem is that both the banking mess and worryingly high public debt are symptoms of an underlying problem. Because the Reinhart-Rogoff book is largely an exercise in measurement rather than theory (while many of the data in the book are new, little or none of the theory is), it can give rise--and has given rise--to dangerously misleading popular interpretations of the data which its authors have so painstakingly assembled.

Reinhart and Rogoff themselves sometimes fall into the trap of simply asserting a direction of causation. This can be dangerous when thinking about the present problems of the world and of the U.S. economy in particular. Thus, for instance, they assert that, "[T]he rise in asset prices [in the United States before the crisis] was being fueled by a relentless increase in the ratio of household debt to GDP, against a backdrop of record lows in the savings rate" (p. 212). But might it not have been the rise in asset prices (or an expectation of continued increases in asset prices) that allowed an accumulation of...